Ben Treece: Why demographics matter

I have mentioned John Mauldin several times. He is a brilliant economist with one of the most widely subscribed-to newsletters in the world. This week in his “Outside the Box” segment, he featured a piece by Harry Dent Jr., an investment newsletter author who has also written several books on economics and finance. In his piece, he commented on the relationship of Baby Boomers to Echo Boomers and what this relationship means for the markets.

Dent pointed out an interesting fact that not many people may realize — Baby Boomers outnumber their successor generation. According to the U.S. Census Bureau, the 45+ age bracket has increased nearly 35 percent since 1960, from 29.3 percent of the total U.S. population to 39.4 percent of the total U.S. population. Conversely, the 44 and younger age bracket has declined from 70.7 percent of the total U.S. population in the 1960s to just 60.5 percent today. The median age has also increased from 29 to 37.

Dent comments on how generations go through gaps. In the late teens to early 20s, the average American is single. From 22-30 the average American is married, has a young family from 31-42, has a family and college-aged children from 46-50 and becomes an empty nester/retiree at 50+. These statistics do not always hold true, that can create these gaps in generations which occasionally result in the preceding generation outnumbering its successor.

Dent took this theory and applied it to the inflation vs. deflation argument that many economists and financial analysts have been debating for the past three years. Dent proposes that the Echo Boomers do not produce goods, but merely spend money, which is a fairly good argument considering the unemployment rate of college graduates right now. Spending without producing is an inflationary action.

If money turns over in the economy without an equal rise in GDP, the action is inflationary.

However, Baby Boomers have been working and producing for decades now, and instead of frivolously spending their cash they have been paying off loans and deleveraging their debt. This is a deflationary action. If debt is paid down then it reduces velocity which results in deflation.

Which generation has more impact? One is deleveraging and the other is spending and loading up on cheap debt as much as possible. The goal of the Federal Reserve is to try to find an equilibrium that allows for the massive deleveraging of the Baby Boomers to offset the increased debt burden being taken on by the Echo Boomers.

Dent commented, and I believe he has an interesting point, that the Fed has continued to pursue low interest rates and cheap debt because it fears deflation and have seen firsthand what it can do to an economy. Remember, in the 1930s the Fed raised rates in order to restrict monetary growth, which some argue worsened the Great Depression.

Dent also comments on the fact that at the top of the 2008 bubble, the federal government was running a $14 trillion deficit while the private sector was running a $42 trillion deficit. Since then, corporations have been holding on to cash and deleveraging as fast as they can in efforts to obtain low interest loans in the near future.

There is a wild card Dent failed to mention in his argument, and that was what impact QE2 will have on inflation or deflation. Following 2008 the Treasury pumped billions of dollars into the Fed in an effort to increase borrowing and economic activity. This money has been “sitting in the cellar” because corporations have not been borrowing; instead they are sitting on cash and deleveraging. Once corporations have paid off high-interest notes and begin to borrow cheap money, that is an inflationary action which could have some unexpected outcomes for the U.S. economy and the global markets.

I have written before that we will likely experience both inflation and deflation in the near future. We currently are experiencing deflation, but in tolerable doses. The question to ask is how much deflation will we experience before inflation kicks in and where will that inflation stop?

Ben Treece is a 2009 graduate from the University of Miami (FL), BBA International Finance and Marketing. He is a partner with Treece Investment Advisory Corp (www.TreeceInvestments.com) and a stockbroker licensed with FINRA, working for Treece Financial Services Corp. The above information is the express opinion of Ben Treece and should not be construed as investment advice or used without outside verification.